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European trade repositories

Daniel Jude, Director, Client Development & Sales - Asset Managers

CME Group

Q3 2013

In the aftermath of the financial crisis, there was acceptance amongst market participants, national authorities and global regulators of a requirement for improved risk management and increased transparency in the derivatives markets.

In 2009, the G20 met in Pittsburgh and agreed that all standardised OTC derivative contracts should be cleared through central counterparties, traded on an exchange or other organised venues and reported to trade repositories. The aim of which, was to voluntarily improve OTC derivatives market in regards to risk reduction and improved transparency.

This approach was welcomed by regulators, but, based on the failure of similar voluntary initiatives in the past it was felt that regulation would be required to ensure compliance and success of such dramatic changes to the financial landscape.

The impact on the global financial markets industry could be compared to the Industrial Revolution of the 19th century. The regulations will impact each step of the trade life-cycle from execution, confirmation, settlement and reporting. Just like the Industrial Revolution the transition will involve a move from manual operations to highly automated processes with an end goal of Straight Through Processing (STP).

Some of this regulation roll-out is now in place and operations teams who were already being stretched to streamline and improve their efficiency in bearish markets are now struggling to cope with the deluge of regulation. The industry is now waking up to the operational complexities and regulatory reporting requirements are the latest to hit the operations teams to do list.

As of 10 April 2013 Regulatory reporting for all asset classes mandated by the Dodd Frank Wall Street Reform and Consumer Protection Act (DFA) has been taking place in the US. The European Securities and Markets Authority (ESMA) created under the European Markets Infrastructure Regulation (EMIR aka The Regulation) currently aims to introduce regulatory reporting in Europe on 1 January 2014 for OTC centrally cleared and OTC bi-lateral rates, credit, FX, commodities, options and exchange traded derivatives.

The inclusion of exchange trade derivatives (ETD) caught the market off guard and has become a major concern for all counterparties who trade these products. The question has been asked: “Why have ETD been included under the European mandate?” These products were not considered to be the cause of the financial crisis and by the nature of the way in which the product is traded i.e. on exchange and the relative transparency appears to be in line with the G20 Pittsburgh summit objectives and that of EMIR for OTC derivatives.

Operational complexity is exacerbated when dealing with multi-jurisdictions due to the lack of extraterritoriality rules and the lack of agreement on equivalence.

Reporting regulation in the US mandates single sided reporting, based on a hierarchy to a swap data repository (SDR). EMIR Regulation requires dual reporting i.e. both counterparties to the trade are obligated to report without duplication certain data to an authorised, approved and registered Trade Repository under EMIR. This will undoubtedly accelerate the emergence and development of multi-jurisdictional SDR/TRs.

Due to the single sided mandate of the Dodd-Frank Act a large population of the buy-side community have only been indirectly impacted by the reporting requirement. This has therefore impacted some buy-side clients mandated under EMIRs understanding, preparation for dual-sided reporting and their ability to implement a tactical solution let alone a long term strategic multi-jurisdiction compliant reporting solution.

Some buy-side firms have begun to look at their possible options and solutions to meet their reporting requirements others are still under the incorrect assumption that their executing brokers, clearing broker, clearing house, middleware will under-take the reporting for them. This is a major concern for regulators as the reporting date approaches.

Some of the questions that are being asked which are useful in regards to ascertaining next steps:

Who can assist me with ensuring compliance to the reporting requirement?

What is the requirement – asset classes, LEI, UPI, UTI?

When do I have to report?

Where do I have to report to?

EMIR allows for “delegation”, what is delegation and can I benefit from this?

Will my executing broker, clearing broker, clearing house, middleware (applicable only where appropriate) accept delegation of the reporting requirement for me or should I self-report?

How do I interact/connect with a trade repository?

What are the criteria for selection of a trade repository? It is suggested that market participants need to select a trade repository based on numerous factors:

Coverage of asset class

Technological capability – inbound and outbound consumption of data

Cost

Simplicity and ease of connectivity

Support and assistance

These are only a few of the major questions that are being asked amongst industry participants.

There is a major shift in the market in regards to the relationship between repositories and buy-side clients. More and more clients are looking to self report and therefore contacting TRs and establishing direct relationships. This is a very significant difference as previously brokers, intermediaries & banks managed the relationships with the buy-side and then had the relationship with SDRs (still this model in the US with single sided reporting) and TRs (nuances with current reporting entities). Traditionally brokers, intermediaries and banks have connected to one TR or SDR yet with the regulation offering freedom of choice to clients, this makes the support, assistance and level of service offered by a TR a major contributor in the client selection process.

ESMA envisages circa 12 authorised TRs under EMIR in the first year of mandatory reporting. Industry experts believe this number will decline over time as the trade repository landscape moves from infancy to adolescence. This is coupled with the view that TRs will be similar to the prime brokerage landscape over the past years, where clients may have limited loyalty to TRs and the initial TR selected will not necessarily be the long term reporting repository of choice.

In truth the landscape is evolving so dramatically and so quickly that information on the reporting requirement is continually changing. Finding a TR that can minimise the operational burden and most importantly educate the buy-side community will define the success of that TR and the TR landscape as a whole.

Whilst there is still a need for more clarity in regards to the reporting requirement especially in regards to third country jurisdictions and equivalence of regulation it is imperative that buy-side firms start to engage with trade repositories as soon as possible.

Resource constraints are a concern for all firms in the financial markets especially with the requirement to re-focus key resources from core activities and system development to regulatory compliance. Trade repositories are conscious of learning lessons experienced by middleware providers as Category 2 Clearing under the DFA approached, they were inundated with requests for onboarding, set ups or enhancements from clients who at the 11th hour realised the impact on the regulation upon them. TRs are therefore using the remaining time available before EMIR reporting regulation comes into force to educate clients via webinars, meetings and presentations with the key message being engage early to avoid non-compliance with the regulation of your jurisdiction.